Georgian Economic Illusions and Realities

Back in 2013, certain statements and events raised hopes that pragmatic reasoning would someday return. Two events are sufficient as an example: firstly, the education minister unexpectedly stating that the labor code does not only concern the employer-employee relationship, but also affects the desire of investors to invest in Georgia, a small country where possibilities are scarce and risks are high; secondly, the issue of normalizing relations with Russia coming under fire following the realignment of the occupational line with the Tskhinvali region, with Russia moving this deeper into Georgian controlled territory. No one is interested in gloating over that – “See, did we not warn you?” The experience of dealing with Russia over the past 200 years has taught us that the only thing Russia respects is power; and we will only have power if we stay close to our friends.

However, soon thereafter any such pragmatism was once again forgotten and we now continue living with our illusions as if nothing has happened. For example, we continue to maintain that Georgia must not be a bone of contention between the US and Russia; we adopt amendments to the labor code that will deliver a hard blow to, for example, the employment of young people, and so on and so forth. Back then, I heard the fallacious claim that extreme poverty in Georgia decreased from 97% to only 93% over the past nine years, but the finance minister nevertheless asserts that the minimum subsistence level, which the Georgian Dream considered to have been incorrectly calculated by the previous government, has now been reduced by five lari compared to the level during the reign of previous government; let alone those unsubstantiated claims regarding the unemployment rate, which is said to still be below 20% and not to have increased even a notch.

Let’s now consider each of these illusions and the reality of the situation. Illusion number one: it is clear that the population, influenced by TV propaganda, easily believes that the previous government did nothing but ruin everything. However, it is easy to recall, amongst other things, the new Tbilisi airport; the partially or completely reconstructed Batumi, Kutaisi, Telavi, Borjomi, Mestia, Sighnaghi, and the old districts of Tbilisi; the hundreds of new hotels and office buildings; the highway to Gori and many internal roads; the rehabilitated water, natural gas, and electricity supply systems; several new hydro power plants and networks. It is desirable to continue and even increase this pattern of development.

Illusion number two: people have become poorer. To counteract this illusion, I will provide two charts. The first shows the increase in average monthly salaries under the previous government (based on official statistics).

I assure you that if these average salaries were shown in US dollars, the increase would be four times higher than is shown on this chart. While some of this growth may be as a result of the legalization of labor reimbursement and the reduction of “cash in hand” employment, this fact gives even more credit to the former government. Regardless of this, it is true that over that period salaries increased, especially in the public sector.

This echoes with illusion number three: that employment in the private sector did not increase at all. The next chart (#2) shows the sectoral changes in employment between the public and private sectors.

As can clearly be seen, against the one-third of public sector jobs that were cut, employment in the private sector increased by more than 50%. However, these statistics only relate to hired employment. The rest of the population is either self-employed or (let’s assume) unemployed. Previously there was some debate whether or not to consider the self-employed as unemployed, but since that debate has stopped, I will also stop arguing over it too.

One thing that needs to be clarified is how many people really live in Georgia. It is rumored that a large segment of the unemployed or self-employed have long left Georgia in search of jobs; meanwhile, thousands of foreigners have settled in Georgia, claiming that the situation is better in Georgia than in their home countries. It seems that many of them have succeeded in finding jobs here and have even started businesses, thereby providing a good example to our citizens. This leads us to the issue of the sale of land to foreigners.

Illusion number four: foreigners will get hold of our land. The authors of this illusion do not have the slightest idea about economics, nor have they ever tried to buy land in Georgia. The assumption that this illusion is fed by a lobby that merely seeks to keep the price of land low in order to get hold of it for themselves appears to be much more trustworthy. I doubt that for the farmers it is of much importance who will own the land – foreigners or those lobbyists. However, what farmers do care about is having the use of state land for free. State owned land is a serious factor impeding the development of the agricultural sector. Under such conditions it is simply impossible for the land market to rapidly develop, especially if foreigners are prohibited from buying land in Georgia. Without the development of the land market, the prospects for an increase in productivity, an improvement in quality and a decrease in costs are zero.

Illusion number five: if our borders are protected from imports, prices will drop and quality will improve. Nothing of the kind has ever happened, anywhere in the world. There is not even a theoretical chance of that happening here. In reality it happens like this:

Let’s assume that a local producer has a more expensive product than an importer, with the price of the local product being 10 GEL and that of the imported product being 8 GEL. The local producer thus

- tries to improve his/her management;
– tries to decrease costs;
– tries to satisfy customers.
Then the government increases import tax by 5 GEL. The local producer has now gained an advantage over the importer and thus
– is no longer interested in improving his/her management;
– is no longer interested in decreasing costs;
– no longer cares about customer satisfaction;
– the price of his/her product first increases up to, and then exceeds, the price of the imported product!

This is how it happens in reality, not in an illusion. It is totally unclear how one can explain the rationale behind the fight against monopolies (because they increase prices) whilst simultaneously artificially putting local producers in monopolistic conditions; especially when the newly established import tax must be paid entirely by Georgian customers.

Illusion number six: the fight against monopolies will push down prices. I really want to believe that the authors of such ideas have heard something more than just the theories of Marx and Lenin. Unfortunately, the government itself is often a source of creating monopolies. In the water, natural gas and electricity supply sector, for example, monopolies were created once the government decided to establish certain rules for the supply system. Had this not happened, private individuals would have reached an agreement among one another or else everyone would have installed their own supply system. But such an action is unlikely given the limited income of most citizens.

For example, what will happen if the electricity tariff reaches 0.50 GEL? Consumption will decrease, tampering with meters will become commonplace, and some people will buy their own personal power generators… Then, the supplier will decrease prices. However, the supplier will also think twice before investing in this business. A higher degree of interference with monopolies than there currently is will enable interest groups to undertake serious lobbying efforts, which will lead us to the situation that Western Europe is in today – one can count on one hand alone the number of traders in Europe in, for example, pharmaceuticals or petroleum. Before taking such an ill-considered step we should first clearly understand why it is that drugstores in Georgia work around the clock and why several tens of firms are engaged in the petroleum trade.

We have heard many angry voices about the monopolized petroleum business under the previous government, with identical prices being cited as a proof of this. However, prices still remain identical today.

Year

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

Bank Revenues

251,400

276,338

395,970

575,327

949,335

1,555,232

1,377,283

1,553,053

2,037,738

2,143,095

Yet another illusion, number seven, is that no growth occurred in Georgia and that every improved economic indicator was a work of fiction created by the previous government. Let’s leave aside the official statistics and bring about more reliable data (that is not derived from surveys). For example, the table below shows the dynamics of the revenues of Georgian banks over the period 2003 to 2012 (taken from the website of the National Bank of Georgia):

Readers probably understand that this eight-fold increase in bank revenues could never have happened under the conditions of economic stagnation, especially when government revenues also (unfortunately) increased at a high rate, as shown in the following chart (# 3) based on data of the Finance Ministry:

Anyone who says that this economic growth has not been translated into improved living conditions for each and every household is absolutely correct. Georgia suffered the most among post-Soviet countries; in the 1990s, its economy shrank four times and has not yet reached best indicators.

The chart below (#4) clearly shows the level of economic decline in Georgia (in percent), compared to Albania and Lithuania in the 1990s (World Bank data):

Consequently, the top priority objective remains the achievement of fast, double-digit economic growth and the sustainability of that growth in order to ensure that this economic improvement reaches each and every household. To this end, the investment climate and economic freedoms need to be further improved. Acting otherwise will slow down economic growth and make it impossible to satisfy everyone to the desired degree – even the financing of social assistance programs will only be possible as a result of economic growth.

Unfortunately, economic growth fell victim to purely political decisions and since 2008, the increase in social costs well exceeded economic growth, thereby entailing a slowdown of the economic growth rate. The chart (#5) below, based on data from the World Bank and the Finance Ministry of Georgia, shows the increase in Gross Domestic Product (in current prices) and in social costs, with the year 2003 at 100%.

Unfortunately, the initial pragmatic policy, which led to an increase in investments and, consequently, to the double-digit growth of the economy in 2007, gave way to a new form of political pragmatism under which the government tried to assume more responsibility for the improvement of the economic conditions of the population, which led to economic downturn.

Illusion number eight: the government got into a large amount of debt. If one looks at the global situation, the national debt of Georgia is below 30%: way lower than the average indicator of national debts. Only oil-rich countries and countries of high economic freedom, such as Singapore and Hong Kong, have state debts lower than Georgia. However, this does not mean that we should have a higher level of debt or that we should now urgently start borrowing. Of course, it would have been better if we had much lower debts, which would have forced us to further improve our economic policy.

Moreover, Georgia’s national debt has been decreasing since 2003, excluding the year 2009 and the new debts resulting from the war with Russia in August 2008. What’s more important, the country reached the point where the annual payments from the state budget to cover international debts decreased from 9% to 2%. The chart (#6) from the Finance Ministry clearly illustrates this fact.

Furthermore, in 2011, without any international or domestic political pressure, Georgia adopted, on its own initiative, an unprecedented Economic Liberty Act setting limits on the budget deficit and national debt; a much welcomed fact in any event. Many international experts were surprised about the government of a developing country taking such a bold step. Without belittling this fact, it must be said, however, that it is important to further reinforce this move by, at the very least, imposing stricter restrictions and further strengthening fiscal discipline.

These are the illusions contrasted with the reality. We must all now think about the future. Economic fiscal policies must now be treated with more responsibility. As was shown above, an increase in social costs led to economic slowdown. From the standpoint of economics, this policy is erroneous – it probably brings some minor political dividends in the short-term, but absolutely diminishes the possibility of resolving problems, including poverty, by means of economic growth. Proof of this is the higher increase of social costs against economic growth, which deprives the private sector of hundreds of millions of lari for development.

The alternative is fast and stable double-digit economic growth. This may lead to an expansion of production, a more effective allocation of resources, the start of new businesses, the employment of more people, an increase in salaries and, as a result, the purchase of better education, healthcare, food and other benefits without assistance from the government (i.e. the taxpayers). Even social assistance is easier and more targeted if it is done voluntarily by ordinary people rather than by bureaucrats.

All that will be easy – and we have seen that it can work – if the state gives us the opportunity by further decreasing the existing low tax rates. Such a policy will enable us to achieve a notable improvement in the economic situation within the next 10 years and to live in much better conditions within the next several decades than those in many developed countries live in today. Any other decision means staying poor for a long time.